The long
litigation odyssey between the government of Argentina and holdout creditors
continues. Debt justice campaigners in Argentina and the USA are enraged about a
new ruling by the New York appeals court in favour of the vulture funds NML
Capital Ltd and Aurelius Capital, which sued for full payment of US$1.3 billion
of holdout debt. The New York court upheld the previous ruling that Argentina
must repay the vulture funds every time it repays the creditors that
participated in the debt swap of 2005. Enforcement is still on hold until the
US Supreme Court has made a decision to take the case. If it is upheld in this
last instance, Argentina would face the choice between paying vulture funds that
speculated on the country’s bankruptcy after the financial crisis of 2002,
which is forbidden by Argentine law, or defaulting on the restructured debt too.

Flawed
interpretation of equal treatment

The US court rule is mainly based on the pari passu (parity) clause in bankruptcy
proceedings, which says creditors should be treated equally and without
preference. On this basis, the US court decided that, when Argentina pays the
creditors that participated in the debt restructuring, it has to pay the vulture
funds that expect full payment too. But, as Jubilee USA put it, “their interpretation of the parity clause is deeply flawed”.

This view
is shared by the international community, as the relevant international organisations
find that vulture funds undermine inter-creditor equity. The United
Nations’ responsible lending and borrowing principles are that “lenders should be willing to engage in good
faith discussions with the debtor and other creditors to find a mutually
satisfactory solution”. That has certainly not happened in this case.
Argentina has recently offered an alternate payment plan to holdout
creditors that was essentially the same deal taken by the 92 percent of
creditors that participated in the debt restructuring after Argentina’s debt
crisis in the early 2000s. But the holdout creditors rejected the plan.
Offering them full payment would put Argentina in a difficult position, as the
UN principles do not approve of arbitrary discrimination among creditors.

Devastating
implications for debt crisis management

The US
court ruling might have severe consequences for the functionality of the international
financial architecture. A recent paper on sovereign debt restructuring by
International Monetary Fund (IMF) experts said that the impacts are already being
felt. The IMF finds that “litigation
against Argentina could have pervasive implications for future sovereign debt
restructurings by increasing leverage of holdout creditors … the ongoing
Argentina litigation has exacerbated the collective action problem”. The US
court decision would undermine future debt restructuring as it gives new
leverage to holdout creditors suing for full payment. In consequence, “holdouts will multiply and creditors who are
otherwise inclined to agree to a restructuring may be less likely to do so due
to inter-creditor equity concerns”.

Jubilee USA reports that the IMF’s Managing
Director Christine Lagarde planned to file an amicus brief to the US Supreme
Court in support of Argentina, but she was stopped from doing so by
intervention from the US Treasury. The USA is the IMF’s largest shareholder and
is endowed with a de facto veto right
over its decisions. European governments such as France supported Argentina in
this case. German courts had previously declined to accept vulture fund claims.

New
dangers for financing development and poverty eradication

The US judges said that the ruling would not have
implications elsewhere because “Argentina
has been a uniquely recalcitrant debtor”. However, Eurodad
researchhas shown
that vulture funds are a permanent annoyance for debt restructuring that is
made in good faith, including for the world’s poorest countries. The African
Development Bank (AfDB) states that 11 heavily indebted poor countries have
been targeted in 46 law suits. The costs could amount to 13 per cent of each affected
countries’ Gross Domestic Product (GDP). It finds that “vulture funds grind down poor countries in cycles of litigation, a practice
referred to as ‘champerty’ and largely unknown in African legal systems”.
The problem became so severe that the bank had to set up the African Legal Support Facility to help poor countries defend
themselves before foreign courts. The facility diverts scarce resources from
the AfDB’s core businesses in financing development and poverty eradication.

Vulture
fund law suits are obviously good business for the law firm industry in
financial centres such as New York and London. However, in order to make sure that aid can
be used for more important purposes, Eurodad calls on governments to enact legislative
changes at the national level to prevent vulture funds from using national
courts to pursue their claims in the first place. Such legislation should make
profiteering in defaulted sovereign debt illegal.

First steps
in this direction have been made through vulture fund legislation in Belgium and the United Kingdom. However, their scope could be
enhanced further.

Vulture
funds have also caused troubles for Greek debt restructuring. While 100 per cent of sovereign
bonds covered by Greek law could be restructured, the holdout ratio was 44 per
cent in the case of Greek government bonds issued under English law. Such
holdouts have created tremendous extra costs for Greece, and for all the
European taxpayers who are ultimately backing the EU’s bail-out instruments
currently applied in Greece. Jubilee Debt Campaign UK has called on the British
government to enhance the law, but this has not yet happened.

What
next?

The US
court ruling has once again unveiled both the ineffectiveness and unfairness of
the current debt governance regime. The US court rejected the view that it
would give too much leverage to creditors and suggested that governments should
use collective action clauses (CACs) that would bind bondholders to majority
decisions. Indeed, given the Greek experience, the EU recently introduced the
rule that all new Eurozone bonds contain such
clauses. But the IMF finds that such clauses are of limited use: “the court’s confidence in the salutary
benefit of CACs appears somewhat optimistic given the ability of holdout
creditors to take blocking positions in individual bond issuances”.

The IMF
suggested a new statutory debt workout mechanism as a more effective
alternative. However, according to information obtained by Eurodad, the US representative vetoed the proposal in the IMF’s Executive
Board, condemning the IMF to pursue piecemeal second-best reforms.Meanwhile, the UN took over the development of new debt workout
mechanisms.

In a
comment on the US court ruling, Jubilee South Argentina stressed that attention needs to be
paid to the origins of Argentina’s debt. Even if rolled over in later times,
much of the debt built up originally took place during the time of the military
dictatorship and the ‘dirty war’ in which more than 30,000 people were killed.
It would therefore qualify as ‘odious debt’. Moreover, Jubilee South questioned
whether New York courts are a competent jurisdiction to rule over Argentine
debt and accused the Argentine government of acting unconstitutionally. They
demand that a thorough debt audit should be conducted and claim it is necessary
that “both the international community
and the government of Argentina recognize that the country has every right and
all the required evidence to denounce and nullify both the illegitimate debt
contracts that have been imposed against the will and rights of the Argentine
people, as well as the renunciation of sovereignty and jurisdiction”.

According
to Jubilee South, a new strategy on sovereign debt restructuring must put “the defence and promotion of human rights
over the claims of capital, as relevant domestic and international law demands”.